INTRODUCTION

The previous two chapters have considered the determination of optimal commodity and income taxes. In practice, if the derived tax rules were to be implemented it would be likely that a major upheaval of the fiscal structure would be required. To be willing to enact such a major change would require the policy maker to have considerable faith in the accuracy of the policy advice. Taking this into account, many countries have opted in favour of gradual policy reforms which involve slowly phasing in some taxes and removing others. The design of such reforms will be the subject of this chapter.

The theoretical literature on policy reform has been concerned with characterising when there exist feasible reforms that satisfy the policy maker's objectives and with determining the optimal direction of reform. For the purpose of formal analysis, reforms are always interpreted as differential changes in the vector of policy instruments. This is the limiting interpretation of the reforms being small.

This chapter will review the standard analysis that has been developed for determining the existence of worthwhile reforms in the vector of consumer prices. The inverse optimum problem, which calculates the welfare weights of households implied by a given set of policy parameters, will be related to this analysis and the concept of marginal social cost will be discussed. Several applications of these methods, including empirical investigations, will be described.